The new year has begun with somewhat of an extension of the now legendary ‘Trump rally’ which ensued immediately after the US election in early November. Global equities have generally been well bid as the so-called ‘reflation’ trade marches on. Markets are anticipating fiscal stimulus in the form of accelerated government spending, lower taxes and less regulation. Meanwhile, bonds have done modestly better since last year’s rout, which was exacerbated by December tax-loss selling, but generally remain in the doghouse as investors fear higher inflation and larger government deficits.

Looking back, 2016 will be remembered as the year of surprises. The consensus was wrong so many times, people have begun to distrust polls and predictions altogether. The UK’s decision to leave the European Union, or “Brexit” vote and Donald Trump’s election as President of the United States were not supposed to happen, at least according to public opinion polls and the popular online betting auctions.

Then, late in the year the Organisation of Petroleum Exporting Countries (Opec) was surprisingly able to agree on production cuts for the first time in eight years. It was perhaps fitting then that the Chicago Cubs managed to win the World Series baseball championship for the first time since 1908. Two-thousand sixteen was the year of the underdogs!

Perhaps the biggest underdog of 2016 was the stock market. Very few pundits were looking for the strong gains which eventually unfolded, albeit most of the bump occurred in the final few weeks of the year. Underdog sectors such as energy and financial services shares led the charge after being left for dead earlier in the year.

The major stock market averages, which had their worst two week start ever in 2016, ended up solidly in the black. The S&P 500 registering an 8.5 per cent increase while the MSCI World Stock Index advanced by 4.45 per cent.

For 2017 and the years ahead, investors could do well to remember recent history and prepare for the unexpected. Forecasts and predictions are valuable to a point, but world events and their related financial market reverberations can be quite unpredictable in the short run. Still, everyone needs a plan. Each individual should have a strategy which includes contingencies for changes in one’s personal circumstances and for potentially volatile markets.

An investor looking to purchase a home within the next six months, for example, should have plenty of cash on hand so as not to be forced into selling securities at a discount if markets are misbehaving when the liquidity is required.

At the same time, investors should not be too cautious. Those who emotionally sold stocks around either the UK Brexit vote or the American election missed out on substantial upside when equities rallied sharply afterwards. At LOM, we stay fully invested but continued to rotate among sectors and asset classes.

Going forward, investors have reason for both optimism and caution. We see a world of change unfolding in 2017. In an earlier article for this column, I wrote about the three D’s which represent powerful long term market headwinds: debt, demographics and deglobalisation.

All these trends tend to work against economic growth and therefore corporate profits and, ultimately share prices. The generally pro-business Republican party victory in America has successfully unleashed animal spirits in the markets, but in reality, none of the three “D” trends have gone away. Debt and deglobalisation may actually be more of a problem under a Trump-led US administration.

However, potentially offsetting my troublesome 3 D’s, I now offer two more constructive D’s: deal making and deregulation. No matter what your feelings are about America’s new President, you likely agree that Trump is a deal maker. Clearly, his personal business success was founded on the art of the deal and this characteristic perhaps sets him apart from more traditional politicians.

Even prior to beginning his official term, the Donald has taken on a plethora of issues from job creation, to healthcare and trade. Key issues presently hung up in Washington’s ongoing political stalemate may now have a better chance of finally being solved, or at least resolved.

The world’s largest economy is very polarised on many fronts. Can Trump bring opposing parties together? Let’s be hopeful. Although he ran as a Republican, Trump’s policies are quite ‘populist’ which makes them somewhat ‘Democratic’ by definition. Certainly his philosophies on protectionism, higher wages, job security and worker benefits at the expense of corporate profitability have appeal on the other side of the political aisle.

With so many special interests and personalities in Washington, deal making has the potential to move things along.

Deregulation, or rolling back onerous laws, oversight committees and outdated tax policies also has the potential to be a massive economic shot in the arm, but it requires a deal maker, or one could even say a ‘rain maker’ in Wall Street parlance.

The new administration will start by attempting to repeal the Affordable Care Act, also known as Obamacare. It is difficult to imagine a new system any less efficient. A more ‘free market’ approach could be very helpful.

On the banking front, a repeal of Dodd Frank, or at least a rollback of the more restrictive mandates such as the Volker rule could begin to help bank profitability. Having worked in the financial sector for multiple decades, I can personally attest to the excessive burden of regulations. Citizens need to be protected and the government should not always be left on the hook for bad practices, but how much regulation is enough?

For 2017, we expect a gradual improvement in the global economy and greater participation from lagging non-US equity markets. European stock markets underperformed the US by over 10 per cent in 2016. Relative bargains are available for those looking diligently, notwithstanding the evolving political challenges inside the somewhat more fractured euro area.

In terms of sectors, expect an ongoing rotation under the surface of the major averages. I wrote about the financial and healthcare sector stocks as being favourites last November and still consider these sectors as top choices. Financial stocks, however, are up 27 per cent since election day and need to consolidate recent gains.

We are optimistic on rates and deregulation which clearly will help the financials but believe it important to be more selective at these higher prices. This could be said for the market as a whole. Healthcare has gone the other way and large biotech looks even more enticing at these levels.

In fixed income, we also continue see value in certain issues but advise having some shorter duration positions and floating rate securities. Barring a major geopolitical shock, the Fed will likely stay on its path of gradually raising interest rates. The key word here, however, is ‘gradual’ which should allow room for many bond funds and individual securities to do okay by at least earning their coupon during the course of the year.

Overall, this is a good time for investors to stay diversified. Maintaining a balance between stocks, fixed income, and among the various subsectors within these broader asset classes may very well mean the difference between success or failure in the years ahead.

Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.

What’s next for the markets in 2017?

What youNeed toKnow

1. For a smooth experience with our commenting system we recommend that you use Internet Explorer 10 or higher, Firefox or Chrome Browsers. Additionally please clear both your browser's cache and cookies - How do I clear my cache and cookies?
2. Please respect the use of this community forum and its users.
3. Any poster that insults, threatens or verbally abuses another member, uses defamatory language, or deliberately disrupts discussions will be banned.
4. Users who violate the Terms of Service or any commenting rules will be banned.
5. Please stay on topic. "Trolling" to incite emotional responses and disrupt conversations will be deleted.
6. To understand further what is and isn't allowed and the actions we may take, please read our Terms of Service